Chapter 3 Interest Rates and Security Valuation

FINC 311 Markets and Institutions

T/F At equilibrium, a security's required rate of return will be less than its expected rate of return.

False

T/F If interest rates increase, the value of a fixed-income contract decreases and vice versa.

True

T/F A fairly-priced bond with a coupon less than the expected return must sell at a discount from par.

True 

T/F All else equal, the holder of a fairly-priced premium bond must expect a capital loss over the holding period.

True 

T/F All else held constant, the longer the time to maturity, the lower the security's price sensitivity to an interest rate change.

False

T/F All else held constant, the greater a security's coupon, the lower the security's price sensitivity to an interest rate change.

True

T/F For a given interest rate change, a 20-year bond's price change will be twice that of a 10-year bond's price change.

False 

T/F Any security that returns a greater percentage of the price sooner is less price volatile.

True

T/F The lower the level of interest rates, the greater a bond's price sensitivity to interest rate changes.

True

T/F The coupon rate represents the most accurate measure of the bondholder’s required return.

False 

The required rate of return on a bond is:

the interest rate an investor can expect to receive on a security given the security’s level of risk.

Which of the following bond terms are generally positively related to bond price volatility?

1. Coupon rate

2. Maturity

3. YTM

4. Payment frequency

II Only.

The interest rate used to find the present value of a financial security is the:

required rate of return

You would want to purchase a security if the price is __________ the present value or if the expected return is __________ the required rate of return.

less than or equal to; greater than or equal to

T/F All else held constant, the higher the interest rate is the higher the duration.

False

Duration is:

the weighted average time to maturity of the bond's cash flows.

All is held constant, the __________ the coupon and the __________ the maturity; the __________ the duration of a bond.

larger; shorter; shorter

A decrease in interest rates will:

increase the bond's duration.

The basic principle of valuation states that the value of any asset is:

the present value of all future cash flows generated by the asset.